My wife and her sister recently bought a small house for their elderly parents to live in. It is just around the corner from the sister so it is very convenient in terms of care giving. The parents will pay utilities and a rent about 50% of the market rate. The sisters will pay for any repairs, cap improvements, etc. There was a sense of urgency in completing this transaction quickly and some due diligence slipped into cracks - such as how mortgage interest will be handled. It is not really rental property given it is not rented at market rate, it is not a second home given it is around the block for the sister (but is 800 miles from my wife). Any insight would be greatly appreciated. Thanks in advance.

Did they both put the same amount of money towards the down payment and other closing costs?

How are actual carrying costs being handled? Are mortgage, taxes, insurance, etc., being shared evenly?

Will they be contributing evenly for any repairs/maintenance?

That would probably be the easiest situation, and easy to support with respect to IRS - and they'd split it 50/50.

If it isn't "even", then they should have some sort of logical and reasonable way of splitting costs, such that they could split the mortgage interest proportionately.
If there is some consideration being given for the sister who is closer, because she would be contributing "work" rather than money, that would be more difficult to calculate. It would need to be "reasonable".

Another possibility if the "official" way to split the deductions isn't what they "want" (especially if there is an asymmetry in the amount of work involved) is that one of them could gift some money to the other, for the extra effort. (This might not be enough without triggering gift tax issues. But gifting can go between each combination of spouse: sister to sister; you to sister; ditto if sister is married...)

I expect it's worth consulting a lawyer, but my offhand impression is that neither of the daughters is entitled to claim home mortgage interest, but you could probably treat it as a rental property, with a gift to the parents of half the rent (assuming the foregone rent is less than $4k/month or so), and deduct the mortgage interest (as well as depreciation, etc.) for the rental, subject to whatever passive activity loss rules might apply.

Thanks for the quick response. In answer to your questions, everything is strictly 50/50. A question not specifically articulated is Do they report the non-market rate "rent" from their parents as income? When the time for filing comes closer, we will consult a tax expert, but I'm just trying to get a heads-up for planning purposes.

Iorek wrote:I expect it's worth consulting a lawyer, but my offhand impression is that neither of the daughters is entitled to claim home mortgage interest, but you could probably treat it as a rental property, with a gift to the parents of half the rent (assuming the foregone rent is less than $4k/month or so), and deduct the mortgage interest (as well as depreciation, etc.) for the rental, subject to whatever passive activity loss rules might apply.

Oops - lorek is right.

This isn't a "home" and it isn't a "rental".

Be very careful about "gifting" half of the "fair rent 'value' ".

IF you are going this route, then consult a tax attorney or accountant.

It probably won't pass the giggle test unless the parents PAY a fair market rate, with checks to document.
What the IRS would do (this is IF there is an audit, obviously, but declaring rental income and deductions increases the chances) with any *separate* gifts?
It would probably depend in part on the amounts involved. A token gift is one thing. Gifts equal to half the rent...?

However, there are significant tax benefits of getting this properly used as a rental property. Utilities, repairs, insurance, etc., become tax deductible.

One way to start is NOT to have parents pay utilities, repairs, etc. Have them pay more rent instead, and see if it gets close to fair market value.

Any day that a property is rented to a family member for less than fair market rent is considered a day of personal use, so in this situation you would have 100% personal use and no rental property for tax purposes. The otherwise allowable deductions for real estate tax and mortgage interest would be deductible as itemized deductions on Schedule A - 50% for each sister assuming each paid half.

Mortgage interest is deductible on a principal residence and one other. Whether a home that is not your principal residence is located across the street or 1,000 miles away is irrelevant in determining its classification as a second residence.

The below-market rental income should be reported on line 21 of Form 1040.

MarkNYC wrote:Any day that a property is rented to a family member for less than fair market rent is considered a day of personal use, so in this situation you would have 100% personal use and no rental property for tax purposes. The otherwise allowable deductions for real estate tax and mortgage interest would be deductible as itemized deductions on Schedule A - 50% for each sister assuming each paid half.

Mortgage interest is deductible on a principal residence and one other. Whether a home that is not your principal residence is located across the street or 1,000 miles away is irrelevant in determining its classification as a second residence.

The below-market rental income should be reported on line 21 of Form 1040.